10/10/2012

I was recently speaking with a pension officer, and asked him about
investment opportunities he was looking for. He replied “Well, we are actively
looking for a good emerging markets fund”.

The investor was interested in emerging markets because he believed they have significant appreciation opportunities uncorrelated to the U.S.
market. He cited specific data that demonstrated the potential.

The answer was thorough and well-researched, but it still begged the question: Was
he looking for an emerging markets fund, or was he really looking for uncorrelated
opportunities with significant appreciation potential (criteria which he believed emerging markets happened to satisfy)?

The distinction is important. I speak with a lot of investors
who ask for specific strategies by name. All too often they are searching for characteristics
that can be satisfied by more than one thesis. The
problem is there is no easy bucket in the portfolio for “significant appreciation
potential with little to no correlation to U.S. equities” so people don’t
generally ask for it by name. Furthermore, when people develop a thesis, they
often get tied to it and lose focus on the original problem the thesis was meant to solve.

When helping investors, I always try to ask more questions and get
to the deeper layers. Why are emerging markets attractive specifically? What
characteristics make them appealing? What need do they satisfy in the portfolio?
If a fund fits all of those needs but is not focused on emerging markets, could it still
be considered attractive?

On the capital raising side, I have seen how funds that ‘check all
the right boxes’ raise the most capital. Unfortunately, if a strategy checks
all the right boxes, it’s highly likely that it has or will be crowded with
capital by others who believe in the same boxes. The best opportunities I’ve
found have been harder to define, often because competing investors don't have a clear place for them in their portfolios (where do you put electricity node arbitrage, trade-claims, mutual fund timing arbitrage, et al?)

As an investor and an allocator, it’s critical to understand what
you really want, and to uncover all of the potential opportunities. The
industry has settled on arbitrary terms to describe different investment
strategies (distressed, long/short, credit, event-driven, etc.) but don’t let
them constrict you. Focus on the problem you need to solve, and allow for the
possibility of many investment theses that can solve it.

10/02/2012

I recently had a conversation with a manager about what many investors say, and what they really mean when they say it. As
a third-party marketer, I would often start the conversation with is “what strategies
are you looking for?” Or “what kinds of allocations are you looking to fill?”

Their answer was usually something specific like “we’re
looking closely at China” or “we’ve allocated heavily to gold recently.”

Importantly, the answers above are one or more questions
away from what your investor is really looking for.

If you ask “why gold?” You may get a thesis on fear of hyperinflation,
on gradual weakening of the U.S. dollar relative to other currencies, increased
demand expectations on the retail side, or a combination of the above.

If you ask “why China?” You may get a thesis on growth, on specific
industries in China, a contrarian approach given that China is out of favor, et
al.

If necessary, ask more questions to get deeper into the rationale.
When you know the core thesis it will completely change the nature of the
conversation. Now you will be able to frame your fund in terms of their
pre-existing thesis, rather than pitching your fund without context. If your
fund goes against the thesis, you will have a more difficult battle, but at
least you will know what you’re up against.

10/01/2012

Your fund fits into one (or more) standard bucket – long/short equity, global macro, distressed debt, event-driven, etc. These monikers are ubiquitous in the industry, and investors will ask for them by name. Despite this, these buckets are completely counterproductive in your marketing pitch, and you must learn to look through them.

I want to demonstrate another way to look at your fund with a real-life story. The example comes from an excellent book called “the Innovator’s Dilemma” which I highly recommend for any manager and marketer. In the example, a chain-restaurant wanted to market their milkshake more effectively. (Bear with me—this applies directly to your fund.)

How would you classify a milkshake? Some might say it’s a beverage, a snack, or a dessert. Most marketing professionals would begin their marketing effort by dividing the world into demographics by race, age, gender, or ethnicity. They would then focus their marketing efforts on the ideal group/group(s) shown to be interested in milkshakes along those lines . This would be a completely rational approach. In this case, our restaurant chain hired an expensive marketing group to do just that—and it failed miserably.

Another marketing group took a different approach. Rather than trying to slice up the world by demographics, they tried to figure out why people were buying milkshakes. In other words, what ‘job’ were people hiring the milkshake to perform for them? Here are their fascinating results:

To learn what customers sought when they hired a milkshake, the researchers spent an eighteen-hour day in a restaurant carefully chronicling who bought milkshakes. They recorded the time of each milkshake purchase, what other products the customer purchased, whether the customer was alone or with a group, whether he or she consumed it on the premises or drove off with it, and so on. The most surprising insight from this work was that nearly half of all milkshakes were bought in the early morning. Most often, the milkshake was the only item these customers purchased, and it was rarely consumed in the restaurant.

The researchers returned to interview customers who purchased a morning milkshake to understand what they were trying to get done when they bought it, and they asked what other products they hired instead of a milkshake on other days when they had to get the same job done. Most of these morning milkshake customers had hired it to achieve a similar set of outcomes. They faced a long, boring commute and needed something to make the commute more interesting! They were "multitasking"-they weren't yet hungry, but knew that if they did not eat something now, they would be hungry by 10:00. They also faced constraints. They were in a hurry, were often wearing their work clothes, and at most had only one free hand.

When these customers looked around for something to hire to get this job done, sometimes they bought bagels. But bagels got crumbs all over their clothes and the car. If the bagels were topped with cream cheese or jam, their fingers and the steering wheel got sticky. Sometimes they hired a banana to do the job, but it got eaten too fast and did not solve the boring commute problem. The sorts of sausage, ham, or egg sandwiches that the restaurant also sold for breakfast made their hands and the steering wheel greasy, and if customers tried to drag out the time they took to eat the sandwich, it got cold. Doughnuts didn't last through the 10:00 hunger attack. It turned out that the milkshake did the job better than almost any available alternative. If managed competently, it could take as long as twenty minutes to suck the viscous milkshake through the thin straw, addressing the boring commute problem. It could be eaten cleanly with one hand with little risk of spillage, and the customers felt less hungry after consuming the shake than after using most of the alternatives. Customers were not satisfied that the shake was healthy food, but it didn't matter because becoming healthy wasn't the job for which they were hiring the product.

The researchers observed that at other times of the day, it was often parents who purchased milkshakes, in addition to a complete meal, for their children. What job were they trying to get done? They were emotionally exhausted from repeatedly having to say "No" to their kids all day, and they just needed to feel like they were reasonable parents. They hired milkshakes as an innocuous way to placate their children and to feel like they were loving parents. The researchers observed that the milkshakes didn't do this job very well, though. They saw parents waiting impatiently after they had finished their own meal while their children struggled to suck the thick milkshake up the thin straw. Many were discarded half-full when the parents declared that time had run out.

Segmenting the market along demographic or psychographic lines indeed provides information on individual customers. But the same busy father who needs a viscous, time-consuming milkshake in the morning needs something very different later in the day for his child. When researchers asked customers who have multiple jobs in their lives what attributes of the milkshake they should improve upon, and when the researchers then averaged each consumer's response with those of others in the same demographic or psychographic segment, it led to a one-size-fits-none product that didn't do well any of the jobs that customers were trying to get done.

Who is the quick-service chain really competing against in the morning? Its statistics compare its sales with the milkshake sales of competing chains. But in the customers' minds, the morning milkshake competes against boredom, bagels, bananas, doughnuts, instant breakfast drinks, and possibly coffee. In the evening, milkshakes compete against cookies, ice cream, and promised purchases in the future that parents hope their children won't remember.

Knowing what job a product gets hired to do (and knowing what jobs are out there that aren't getting done very well) can give innovators a much clearer road map for improving their products to beat the true competition from the customer's perspective-in every dimension of the job.

For those of you that are still with me (I know that was long), how does this apply to your fund? Ask questions of your investors to find out what jobs they want performed in their portfolio. Maybe they are afraid of certain things, or maybe they are feeling opportunistic about others. If they say they are looking for “a good long/short manager,” ask further. Why long/short specifically? Only when you understand the core of what they are really after can you begin to apply for the job. Take the time to ask —if you don’t, you risk everything. The minute your pitch diverges from their need is the minute they will stop paying attention, and you’ll likely never get it back.

06/20/2012

Years ago I had the pleasure of sitting in a meeting with a well-known black box algorithmic fund and a potential investor. The investor began asking questions about investment process and the black box consistently gave vague non-answers. The investor got frustrated but continued asking pointed questions about the investment process.

Eventually the manager answered, “sorry, that’s proprietary.”

The investor leaned in and replied, “so is my money.” End of meeting.

A black box is a hedge fund that leaves investors in the dark.

The other day I had a conversation about how non-algo hedge funds can make themselves just as obscure without even realizing it. A lack of effective communication and technology limitations can turn a typical hedge fund into a black box. Here are some ways how this occurs:

1. Lack of Holdings/Exposures

The best way to invest in AAPL for 2/20 is by investing in a hedge fund without holdings transparency.

Some funds are willing to share holdings on a delay, or give high level geographic and industry exposures. This at least gives an investor a sense of the general style and risk approach of the manager.

Without anything, an investor has no idea where a the hedge fund fits in their broader portfolio, and no idea whether they're throwing darts a the wall with their eyes closed.

2. Lack of Granular Performance

About 2 years ago, I met with a fund that had high monthly volatility in their returns but insisted there was a sound risk management system in place. I asked if they’d let me see daily returns. (I wanted to see if the daily swings weren’t as bad as the monthly numbers indicated.)

They said, “sorry, but we don’t make daily returns available.”

I asked, “but you have them?”

“Yes.”

We walked, and the fund went under 6 months later.

The standard practice is for hedge funds to report monthly (or even quarterly) returns. In between those 30-90 days, one often has to trust that the manager isn’t taking undue risk. Is the manager making up for a loss, or doubling down on a gain? Who knows.

It may not be intentional, but the industry standard monthly returns can leave investors exposed and in the dark.

3. “Flexible” Risk Limits

There is a well-known quote on the 1st amendment that states: “If we don’t believe in freedom of expression for people we despise, we don’t believe in it at all.”

The same concept applies to risk limits. If you don’t believe in hard risk limits for the trades you really like, then you don’t believe in risk limits at all.

A flexible risk limit “at the manager’s discretion” is tantamount to no limit. Without hard limits, investors can’t know what they’re getting into. Investors need assurance that risk taking isn't a free-for-all (especially if returns are only being disseminated monthly)

4. No process transparency

The typical black box is driven by an algorithm that follows a very specific investment process. The process and the code behind it is what’s hidden from investors.

An accidental black box occurs when the investment manager isn’t clear about explaining their own investment process even when they want to be. Sometimes the manager simply does a poor job communicating how they select investments. At other times the manager doesn’t even have a clear grasp on their own system for selecting investments.

Often it’s when managers step out of their process they wind up in unfamiliar territory and get themselves in trouble. They also drift style. Investors need to be confident that a manager is investing according to their mandate and skillset.

Managers need to develop a step-by-step approach for how they find and execute good investments and make it easy for investors to understand.

5. Jargon to Death

I wanted to make a special category for poor communication through jargon because I see this so often.

Managers spend all day dealing with complex financial products. They get used to the lingo. Many don’t turn it off when the investor walks in the room. A manager may think their reverse engineered du-ponte model coupled with a DDM fundamental model and an EMH macro overlay makes total sense to investors. It doesn’t.

If the manager gives the presentation in Swahili without realizing it, the investor might as well be investing in a black box.

I hope this was helpful. Please leave your comments below and feel free to email us at info@clarityspring.com with your feedback!

06/18/2012

Investor update letters are some of the most important marketing collateral that any hedge fund (or any investment firm) produces. Warren Buffett famously built a brand for himself around his annual letters to shareholders. Bridgewater’s daily observations have become a staple in the industry and have boosted their brand considerably.

I received 27 update letters this month from hedge funds (and we're a service provider, not an investor). Assume your investors are receiving many more (50+). They are likely on the distribution lists of every fund they've considered in the past.

How do you get your letter to the top of the stack given the daunting number of competitors?

Fortunately it’s not as hard as you might think. Your competition is severely deficient in two key areas:

Headlines

Targeted Content

Vanilla Headlines

Research shows that on average, 8/10 people will read email headlines, while only 2/10 will read the content. A ‘grabbing’ headline is critical to drawing eyes into your content.

Of the 27 investor letters I received this month, every single subject line was a minor variation of the same thing. Here are the first 8 of them (fund names replaced with ‘xyz’):

xyz's Monthly Update - May 2012

xyz’s Performance Report - May 2012

xyz EST May Return 10.65%

xyz Performance Report

xyz- May 2012 Investor Update

xyz- May Performance Update and June preview...

xyz May 2012 Newsletter

Performance Report - xyz (May 2012)

Weakness #1:

No subject line stands out from the crowd. Why read one over the other?

Weakness #2:

Most imply that the purpose of the email is ‘performance’. The performance is then shared right up front, negating the point of reading the actual letter.

Weakness #3:

Out of the 8 headlines, only one compels the reader to open the commentary letter: “xyz- May Performance Update and June preview...” Even in that case the draw was rather...weak.

Give investors something to chew on. A handful of subject lines that have ‘draw’:

“XYZ May Update & Top 3 Dangerous Market Trends”

“XYZ May Update & The Single Most Important Lesson for Volatile Markets”

“Why XYZ performed so well in May”

“Why XYZ performed poorly in May & why we won’t make that mistake again”

Unfocused Content

Your investors are allocators. Make sure your content is something that allocators care about. Investors buy Berkshire because of who Buffett is and what his investment principles are, not because Burlington Northern has a favorable PEG ratio relative to its peers. Most investors don’t spend their day thinking about security level details, deep specifics of industry competitive dynamics, or nuances of trading execution strategies.

Make your content relevant to the audience:

If you’re going to focus on a security, use it as an example to highlight core investment principles. (Buffett does this for a living.) Talk about why a security's characteristics fit with your beliefs on what makes a great investment. Eg: 'Hidden risks can open up great relative value opportunities' vs. 'GM's defined-benefit plan makes it more risky than its peers.'

Rather than focusing on industry nuances, use insights from market segment to extrapolate high-level themes of interest to allocators. Eg: ‘How sub-prime mortgages may signal problems for the broader economy’ vs. ‘Sub-prime mortgage prices are high compared to historical levels’.

I hope this is helpful in your efforts to market more effectively! Please leave your comments below and as always feel free to contact us at info@clarityspring with feedback.

06/14/2012

This is a long post only because I believe your investment and personal philosophy is the single most important marketing tool you have. It’s also an area where most hedge funds lack severely.

Philosophy Vs. Process

Many funds try to write out or articulate a philosophy, but it often morphs into a description of their investment process. This defeats the purpose entirely. To be clear, the philosophy section answers ‘why’ you do what you do, while process will answer ‘how’ you implement those beliefs.

I often remind managers that people invest in Berkshire Hathaway because they identify with who Warren Buffet is and what he believes. They don't invest because Berkshire starts their process by screening for companies with favorable P/E ratios relative to their peers.

How to Determine Your Philosophy

To help pinpoint underlying philosophy I use the Ray Dalio trick –I take a sentence about what I do or think and ask ‘why’ (up to) 5 times. If you do this, you will almost always end up at a core belief or personality trait that drives your decisions. That is the stuff that makes for great sales pitches and really draws investors in.

Sentences that define what you “believe” and “who” you are (when it helps define a core personality trait) can be very powerful. Examples:

The fun part of our job is in uncovering new ideas that others have missed. We believe that alpha comes from innovation.

The details that others often find mundane tend to excite us, because we believe that’s where the opportunity is. Sometimes the difference between a great investment and a great loss comes down to a footnote. This knowledge drives us to be vigilant in our research (and also keeps us up at night).

We are natural skeptics, especially of ourselves. Our personalities lead us to constantly question each other and look for the angles we may have missed.

Why It's So Important

The reason I value “Philosophy” so much is because the most successful funds I’ve raised money for present their fund according to a very specific formula:

They present ‘why’ they do what they do, ‘how’ they do it, then finally ‘what’ the features of the fund are.

They draw the investor in with their beliefs, then present the fund as merely an extension of those beliefs.

About 95% of funds I meet do the opposite. They focus on ‘what’ they do – the features, the expertise, the track record, and the process. Most people naturally describe products they’re selling in this way and it’s far less powerful. It almost never gives investors the good ‘gut’ feeling and comfort (see marketing mistake #1) that they need to make an investment. Frankly it is also less interesting.

To highlight the distinction – Apple easily has the most successful marketing of any consumer company of our time. Notice how their advertising focuses on their core beliefs rather than features:

It’s a subtle difference but it is extraordinarily powerful (and hopefully helpful as you seek new investors.)

05/23/2012

We wanted to thank everyone for the positive feedback from our article on Top 5 Hedge Fund Marketing Mistakes. Based on your emails we've put together another list of 5 tips. We hope this helps with your capital raising efforts.

Here are 5 common mistakes many hedge funds make when marketing their fund:

5. Not telling the story

Think back to your high school history class. Do you remember anything about the Battle of Sterling in 1297 from your textbooks? Doubtful.

If you’ve seen the movie Braveheart however, you probably remember vivid speeches, character traits, and possibly some facts around the plotline.

The point is that people don’t remember facts by themselves—they remember a narrative. Unfortunately, the story is the part of the marketing process that many managers overlook.

Investors need to identify with why you invest and who you are before they’ll take interest in what you do. Focus your pitch on the story, not the textbook facts.

Include critical moments in your life or career that developed your character, key educational insights (from school or the job) that defined your investment process, and revelations that formed your investment & personal philosophy.

4. Thinking 1 move ahead

Let’s say you kick off the marketing process with a great meeting. You told your story, and everything felt great.

You now face two problems. If you are unprepared for either of them you could see an unexpected cooling off followed by the kiss of death, AKA “put me on your distribution list.”

The problems:

1. Time. The sales process is long and your prospect will likely forget most of your pitch by decision-time. The worst part of this is that because they forgot they’ll eventually convince themselves that it must not have been so great after all.

2. Internal sales. Do you remember the ‘telephone’ game you played as a kid? If your prospect has to sell your fund to his colleagues internally he will likely do a poor job.

Think three moves ahead by writing the story and pitch as a leave-behind for your prospect. This can either be a brochure or 2-pager.

Now your prospect can reference this document when they need a refresher on why your fund was so interesting, and they can share it internally without diluting the message.

3. Underestimating the operational side

Research consistently shows that over 50% of all fund blow-ups occur due to operational failures, not investment process failures.

Investors know this, and having the right service providers isn’t enough anymore.

To win their trust you need to demonstrate that you've thought through disaster recovery, key employee retention, compliance, succession, conflicts of interest, and potential infrastructure issues. These are big issues so make sure you tackle them head on and show that you take them seriously.

You want to show that your idea, experience, or process are truly unique. This is not an easy thing to do with 13,000 hedge fund competitors trying to make the same case.

Despite the heavy competition, don't over-complicate. A good edge will be straightforward and logical. Start with simple concepts and then extrapolate the uniqueness of your philosophy, process, and expertise from there.

1. Using the Wrong Perspective

Your fund is a potential solution to a problem. You need to thoroughly understand the problem in order to be an excellent solution.

Don’t jump into the presentation right after small talk. Ask questions:

“Are you looking to fill any particular allocations?”

“In what ways, if any, are you looking to reposition your portfolio this year?”

“What concerns do you have with your existing portfolio?”

“Are there any particular key criteria you use to evaluate an investment?”

By asking these types of questions you are displaying an understanding of the investor’s perspective. Their answers will help focus your presentation and make it more relevant to them.

ClaritySpring is the revolutionary technology platform built to help hedge funds market effectively

As most hedge fund investors will attest, finding managers with a true ‘edge’ is an incredibly challenging task.

There are 13,000 hedge funds in existence, and every one of them claims to have an edge over the others. We can't claim to pinpoint the right combination of skills and experiences needed to generate alpha. We can help eliminate some of the noise however.

With the help of our family office and institutional investor friends, here are the most common ‘edges’ they see that aren’t necessarily edges at all:

7. Our Backtested Results are Phenomenal

“It’s kind of like buying the winning lottery numbers after the lottery has already ended. It doesn’t make us feel any better about a fund.”

Despite that opinion, some investors use backtested results to demonstrate that the fund has at least learned from the past.

Ultimately, the disclaimer language speaks the truth: “historical results may not be indicative of future results”. While backtesting a strategy may not be harmful, it also does not ensure that the fund has an edge going forward.

6. I am a Tiger Cub

Two years ago, Absolute Return did an excellent breakdown of the lineage of Julian Robertson’s famous Tiger Management Corp. They found 97 funds that claimed to be ‘Tiger Cubs’. (That’s a lot of offspring.)

How many of those managers were close enough to Robertson to absorb the magic? We don't know, but it's not 97.

The point is that while pedigree is important, it’s also important to understand the depth of the pedigree. There is a huge difference between being personally mentored by Julian Robertson and being the portfolio manager who barely knew him (and was later fired for underperformance.)

4. We Have 30 Years of Experience

This is a picture of Bobby Fischer, the famous chess champion, at age 13. That was the age he played the legendary ‘match of the century’ against an international chess master.

If the average person studied chess for 30 years, would they be able to play at that level?

Probably not.

Bobby Fischer was beating lifelong veterans before he even had facial hair.

There’s always value in experience. However, just because a manager has been alive and employed for 30+ years does not mean they’ve excelled at their work.

Experience is undoubtedly relevant, but not necessarily an edge.

3. We Went to Harvard

Or Columbia, or Yale…

Great schools give students great networking opportunities, and better opportunities to learn from the best.

However, each student takes advantage of those opportunities in different ways. It’s tough to tell just from where someone went to school whether they will truly stand out.

Harvard business school has 900 graduates every year. Some of them go on to be great fund managers, and some of them go on to be great failures. Ray Dalio and John Paulson were graduates of Harvard. The unabomber also went to Harvard.

2. We've Worked Together as a Team for 8 Years

Let’s say the ClaritySpring basketball team is given 8 years to practice together. If we were to play against a team of NBA players that had never worked together and had no coaching, we would lose horribly.

None of us can even dunk.

The picture to the right is an example of a professional team that works together every day and is still absolutely horrible.

Similar to the “we have ‘x’ years of experience” argument, we see a lot of people touting that they’ve worked as a team for ‘x’ years. A great team dynamic is undoubtedly valuable, but it is hard to measure and it doesn’t convey a clear edge over the market.

1. Our Strategy is Uncorrelated

A long-short manager with positive beta recently told a local family office that their strategy was uncorrelated to the market. Bewildered stares followed.

We get it. Investors have asked for uncorrelated strategies, so managers want to deliver them.

However, not every strategy is uncorrelated, nor are they all designed to be. Furthermore, for those that truly want to eliminate beta, historically low correlations do not mean future low correlations. Many investors learned about unforeseen hidden correlations through the events of 2008.

“Correlation does not imply causation.”

Investors need to determine how a strategy is unique, and in what circumstances the edge holds up. Low correlation will be the byproduct of a unique strategy, but it does not explain anything about why an edge exists, nor whether it will persist.

P.S. Correlation is obviously a statistic, and therefore it has the potential to lie. We’ll have a follow up piece about how hedge funds mislead with statistics.

The graphic shows a strategy that has a perfect zero correlation to the benchmark. When the market goes down, the hedge fund goes down, and when the market goes up, the hedge fund goes down.

So...

If you see a manager who is a Tiger Cub, has great backtested results, has 30 years of experience, went to Harvard, is a doctor focused on biotech, worked with his team for 8 years, believes his strategy is completely uncorrelated to the market, and can dunk, will you invest?

We can't answer that question for you, but we hope this piece will elicit some more good questions!

04/11/2012

From our experiences as investors and marketers we have seen a lot (and much of it is quite ugly). Here is a sample of 5 mistakes to avoid.

5. Neglecting PR Opportunities

PR? But what about mass-solicitation rules...

Ray Dalio, founder of Bridgewater was recently featured on the cover of Absolute-Return Magazine, giving an exclusive interview. The funds that ignore PR opportunities do so because they are unfamiliar with the securities laws. If done correctly (ie:legally), TV appearances, magazine articles, and speeches can be a great boost to credibility.

4. Sending Documents Over Email

Do you send your critical marketing and due-diligence documents over email? This could lead to major problems:

Control. This is a security and compliance nightmare. Your critical documents may be forwarded to competitors, regulators, the media, or unaccredited investors.

Feedback. You don’t know which prospects are reading your materials versus which are deleting everything.

Next step. Prospects often read your update, close the email, and move on. There is nothing to draw them in to a further discussion.

1. Missing the point

If the goal in your marketing efforts is 'to raise money' you are approaching it from the wrong perspective. Try focusing on the following:

A. Cultivate trust. Prospects need to trust you personally if they are going to invest. Without this, it doesn't matter how great your investment process is. Your personal story is your opportunity to build rapport.

B. Build confidence. Prospects need to also trust your competence in managing a business, in managing a team, and in capitalizing on investment opportunities. Weave examples of your competence into your pitch to build their confidence.

When you go into meetings and marketing communications with these goals in mind, you will build stronger relationships and instill confidence in your abilities. The money will follow.

03/18/2012

In a previous post we showed reasons WHY the mutual fund industry is losing market share to alternatives and ETFs. The actual numbers are extremely telling of the realities going on in the industry right now.

Mutual funds have been the dominating force in the finance industry since 1940, yet in just 10 years they have lost roughly 20% of their market share to alternative funds and ETFs.

Keep in mind that mutual funds are available to 401k plans and retail investors whereas alternative funds are not, so the numbers don't account for the fact that mutual funds have an unfair advantage in that regard. This point also underscores how mutual fund market share losses are even more severe among the groups that do have access to alternatives funds; institutional and high net worth investors.

We believe this trend will continue. The alternatives industry is continuing to evolve and professionalize, and investors are beginning to get more comfortable with alternatives. Eventually we believe alternatives will open up to retail investors. We are already starting to see 'alternative mutual funds' grow rapidly; a clear sign of the convergence of the two markets.

Below is the data for total assets in each asset structure. Hedge fund data comes from HFRI, mutual fund data from ICI, and Private Equity data from Preqin.

Assets ($m)

Mutual Funds

Hedge Funds

Private Equity

ETFs

Total

2000

6,965

490

713

66

8,234

2001

6,975

539

777

83

8,374

2002

6,383

625

766

102

7,876

2003

7,402

820

872

151

9,245

2004

8,095

972

965

228

10,260

2005

8,891

1,105

1,240

301

11,537

2006

10,398

1,464

1,709

423

13,994

2007

12,002

1,868

2,236

608

16,714

2008

9,604

1,600

2,204

531

13,939

2009

11,120

1,600

2,480

777

15,977

2010

11,821

1,917

2,517

992

17,247

Growth (Annlzd)

5.43%

14.62%

13.44%

31.13%

7.67%

Although ETFs have the smallest market share they are growing the fastest with a 31%+ annual YoY growth rate. All asset structures have grown over time, but mutual funds are the clear laggard of the group.

An area chart of the market share of various different asset structures shows an alarmingly consistent trend. Mutual funds lost share almost every year. The exception was a small post-2008 recoil back to traditional asset classes.

The raw data:

Market Share

Mutual Funds

Hedge Funds

Private Equity

ETFs

00'

84.6%

6.0%

8.7%

0.8%

01'

83.3%

6.4%

9.3%

1.0%

02'

81.0%

7.9%

9.7%

1.3%

03'

80.1%

8.9%

9.4%

1.6%

04'

78.9%

9.5%

9.4%

2.2%

05'

77.1%

9.6%

10.7%

2.6%

06'

74.3%

10.5%

12.2%

3.0%

07'

71.8%

11.2%

13.4%

3.6%

08'

68.9%

11.5%

15.8%

3.8%

09'

69.6%

10.0%

15.5%

4.9%

10'

68.5%

11.1%

14.6%

5.8%

The data indicates that a shift is taking place. The mutual fund industry will lose it's role as the dominant asset structure if current trends continue. Arguably this shift has already taken place with the talent flight over to hedge funds.

The implications of this shift are obviously broad for allocators, managers, and service providers. Industry participants need to respond by recognizing where the attention and resources will be focused on in the future.